Recent analysis from BNY Mellon's Americas Macro Strategist John Velis indicates that the Middle East conflict is exerting a classic negative supply shock on the U.S. economy through three primary channels: higher oil prices, weaker asset portfolios, and increased uncertainty. This has led markets to significantly reduce their expectations for Federal Reserve interest rate cuts within the year, adjusting sharply from slightly more than two cuts priced in before the conflict to well below two currently. However, Velis maintains his own forecast of three rate cuts in 2024, citing emerging signs of labor market weakness that are likely to ultimately dictate the policy path.
John Velis emphasized that the impact of the Middle East conflict on the U.S. economy and interest rate outlook is multifaceted, transmitted through three interconnected channels, creating a compounded negative effect.
1. Higher Oil Prices Channel: Inflation Pressure and Yield Curve Repricing. The conflict directly pushes up international oil prices, constituting a classic negative supply shock. This shifts the aggregate supply curve upward and to the left, leading to higher price levels and constrained real output. Rising oil prices significantly increase U.S. Treasury yields via expectations channels; the recent notable rebound in the 10-year Treasury yield reflects a re-anchoring of market expectations for medium-term inflation, further compressing the Fed's room for monetary easing.
2. Financial Market Instability Channel: Wealth Effect and Dual Suppression of Consumption/Investment. Sharp asset price volatility triggered by geopolitical risks directly削弱 the value of household and institutional investment portfolios, significantly suppressing consumer spending through the wealth effect. Simultaneously, real income losses from high oil prices further squeeze household disposable income, jointly weakening consumer demand. Additionally, increased volatility disrupts long-term financial planning for businesses and households, leading to postponed investment decisions and slowed hiring activity, creating a negative feedback loop.
3. Broadly Rising Uncertainty Channel: Behavioral Suppression and Dual Growth-Inflation Distortion. The叠加 of the first two channels creates a pervasive atmosphere of economic uncertainty. Consumers increase precautionary savings, while businesses delay capital expenditures and expansion plans, ultimately manifesting as "stagflationary" characteristics—slowing economic growth coupled with short-term rising inflation. Velis points out that this is the core macroeconomic manifestation of a negative supply shock, placing the Fed in a dilemma where sticky inflation persists alongside emerging weakness in demand.
Before the conflict erupted, markets were pricing in slightly more than two rate cuts (approximately 2.1 cuts) for the year. Following the escalation of conflict, markets rapidly shifted to a more hawkish pricing; the number of cuts now priced in for the year is well below two (latest CME FedWatch data suggests cumulative easing of about 40-50 basis points, implying a low probability for 1-2 standard 25-basis-point cuts). This reflects strengthened expectations that the Fed will maintain higher interest rates for longer due to inflation pressures. Velis believes this creates a significant dilemma for the Fed: on one hand, sticky inflation coexists with oil price shocks; on the other, signals of labor market weakness are intensifying. While supply-side shocks dominate in the short term, accumulating evidence of demand-side weakness will open a window for easing. Therefore, BNY maintains its baseline forecast of three rate cuts this year, expecting the Fed to gradually enact a dovish pivot once employment data further confirms softening.
In the short term, oil price dynamics remain the dominant variable. If the Middle East situation continues to ease and oil prices stabilize within the $85-$95 range, the market's pessimistic pricing for Fed rate cuts this year could see partial recovery, potentially leading to a阶段性反弹 in U.S. stocks and bonds. However, if the conflict flares up again, pushing oil prices higher, stagflation concerns would intensify, further raising long-end yields and pressuring risk assets. From a medium-term perspective, labor market signals are the decisive拐点. Once non-farm payrolls consistently fall below expectations and the unemployment rate温和 rises above 4.5%, the Fed's window for easing will open, and Velis's path of three cuts could regain market consensus. Investors need to closely monitor the dynamic interplay between stabilizing oil prices, the steepness of the Treasury yield curve, and employment data series.
Risk Warnings: 1. Middle East conflict escalates beyond expectations, pushing oil prices above $100 and triggering uncontrollable inflation. 2. Labor market deterioration accelerates超预期, forcing the Fed to ease significantly提前 but amplifying recession fears. 3. Global demand weakness叠加 with supply shocks increases the probability of the economy陷入 "stagflation."
The Middle East conflict, via three channels—higher oil prices,削弱 wealth effects, and rising uncertainty—is constituting a negative supply shock to the U.S. economy, already driving markets to significantly lower their expectations for Fed rate cuts in 2024. BNY strategist John Velis maintains his forecast for three cuts, emphasizing that labor market weakness will gradually dominate the policy path. While short-term volatility has intensified, medium-term easing potential remains, warranting vigilance regarding the two-way validation from oil prices and employment data.
【Frequently Asked Questions】
1. Q: How does the Middle East conflict specifically impact the U.S. economy through the three channels? A: John Velis outlines three channels: First, rising oil prices directly push up inflation, creating a negative supply shock and lifting Treasury yields. Second, geopolitical volatility削弱 household portfolio values, suppressing consumption via the wealth effect, while high oil prices compress real income. Third, overall rising uncertainty leads to conservative behavior by businesses and consumers, delaying investment, hiring, and major expenditures, ultimately resulting in stagflationary pressures—slowing growth and short-term rising inflation.
2. Q: Why did market expectations for Fed rate cuts in 2024 drop sharply from slightly over two to well below two? A: Before the conflict, markets were pricing in about 2.1 cuts based on the logic of moderate growth and receding inflation. Post-conflict, surging oil prices strengthened inflation concerns, leading markets to believe the Fed will delay or reduce easing due to sticky inflation. Current CME FedWatch tools imply only 40-50 basis points of cumulative easing for the year, equivalent to 1-1.5 standard 25-bp cuts, with hawkish pricing dominating.
3. Q: What is the core basis for Velis's坚持 on three rate cuts within the year? A: Velis believes the supply shock (oil-price-led) is short-term, while labor market weakness is a more structural, long-term issue. Signals are already intensifying, such as the unexpected drop of 92,000 in February non-farm payrolls and the unemployment rate rising to 4.4%. Once employment data further confirms weakness, the Fed will be forced to pivot towards easing to prevent a hard landing; hence, three cuts remain the baseline scenario.
4. Q: Is the current market's pessimistic pricing for rate cuts excessive? A: There is a component of excessive pessimism. Short-term high oil prices and geopolitical uncertainty dominate sentiment, but the logic of labor market weakness is not yet fully reflected in pricing. If oil prices retreat and stabilize and employment data continues weak, there is significant room for correction in market expectations for 2024 rate cuts, potentially leading to a修复性反弹 in U.S. stocks and bonds.
5. Q: Which indicators should investors focus on now to gauge the Fed's path? A: Primarily track whether oil prices stabilize and decline (determining the strength of the supply shock and inflation expectations). Secondly, monitor changes in the U.S. Treasury yield curve (reflecting the growth-inflation博弈). Thirdly, pay close attention to labor market series data like non-farm payrolls, unemployment rate, and initial jobless claims (determining the timing of the easing window opening). The共振 of these three factors will dictate short-term asset direction. It is advisable to control positions, adjust dynamically, and avoid chasing extreme pricing.